Interest Rate Swap (IRS)

• Interest Rate Swap (IRS) is an agreement to exchange cash flows denominated in one currency and derived from a fixed or floating interest rate base
• Party A undertakes to pay fixed interest to Party B, while Party B undertakes to pay agreed floating interest to Party A
• Interest payments are derived from agreed principal, agreed interest rate, for the agreed period and as of the agreed maturity dates
• Original creditor relationships of involved parties are not modified from a legal perspective – parties to a swap transaction remain fully liable for their original interest liabilities (i.e. remain creditors in terms of interest receivable) covered by such swap
• Floating interest rate is fixed – and compared to a fixed interest rate - two business days prior to the start of each interest period
• At the end of each interest period, settlement is made by means of a single payment
• The party with higher swap interest payment due makes the payment – amounting to the difference of parties’ mutually exchanged interest payments
• There are several IRS modifications available, such as:
  • Amortised IRS – nominal amount from which interest is calculated is reduced over the course of the contract term in a predefined manner 
  • Step up IRS – nominal amount from which interest is calculated is increased over the course of the contract term in a predefined manner

• Counterparties may agree on swap cancellation in the course of the contract term
• When interest rate swap is cancelled, its market value is settled by means of a one-off payment, with the transaction and all future liabilities being cancelled - interest payments made prior to swap cancellation are not refunded
• As of the IRS cancellation date, counterparties agree on a price, at which they are both willing to withdraw from the transaction
• Party in a disadvantageous position (loss incurred) pays the agreed amount to the other party (swap market price), at spot value date, thereby cancelling the swap transaction
• Any accrued interest payments outstanding as of the swap cancellation date are included in the swap market price

• Profit or loss from interest rate transactions is affected by interest rate fluctuations
• Losses may be incurred due to the fact that clients find themselves in a disadvantageous position during individual reference periods – i.e. swap payments made by them exceed payments made by the bank
  • In this case, clients pay a difference of the two payments to the bank
  • For clients, this loss represents hedging cost, provided the transaction was used as hedging
  • Hedging protects clients from significant interest rate fluctuations that could result in substantial financial problems
• Beware of consequences of negative interest rates. Under normal circumstances, the hedger pays fixed and receives floating interest rate payments from the bank. In case of negative market interest rates, the fixed rate payer will have to pay both the fixed (positive) and the floating (negative) rates to the Bank.

It is intended for individuals and legal entities - domiciled in the Czech Republic and abroad.